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"Losers always whine about (doing) their best. Winners go home and f*ck the prom queen."
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Tuesday, May 25, 2004

Columnist Watch: Featuring Irwin Kellner

Thanks to Jim Coomes of Thailand who directed my attention to this article. It jives with my analysis below about stagflation and my continued interest in the failure of government indices to measure real inflation.

HEMPSTEAD, N.Y. (CBS.MW) -- Don't look now, but just as inflation is speeding up, the economy is slowing down. Can you say stagflation?

After growing at a pretty good clip in the first quarter, the economy appears to be slowing down during the current period. Retail sales fell in April, pulled lower by motor vehicles. New home construction also declined, while most other data show slower rates of gain.

Ordinarily this would not be cause for alarm except for the fact that price increases are coming on thick and fast. The consumer price index is now almost 2.5 percent higher than it was a year ago; as recently as yearend, the 12-month change was a full point less.

You can blame some of this on the soaring cost of energy. Higher transportation costs are leading many firms to tack on a surcharge to the price they charge for their goods or services.

In other words - higher energy costs are spreading throughout the economy like a cancer. Not surprisingly inflation expectations are beginning to rise as well.

One way to measure inflation psychology is to compare the yield on the regular 10-year Treasury note with the yield on the inflation-indexed note, known as TIPS, for Treasury Inflation Protected Security. The greater the spread, the more worried investors are about inflation.

Currently the spread is almost 2.8 percentage points - the most since 1997. Since this is greater than the current rate of inflation, it shows that investors expect price rises to speed up.

The big question is where does this leave the Federal Reserve? Will it worry more about inflation than about the slowdown?

A lot depends on whether the Fed considers the jump in oil prices to be inflationary or deflationary. But what if it's both? Stagflation was the rule, rather than the exception in the 1970s, who's to say it can't happen again?

At the moment, Alan Greenspan and his band of merry central bankers are widely expected to hike the federal funds rate come the end of June, to show the markets that the Federal Reserve is not behind the curve when it comes to keeping an eye on inflation.

But how can the Fed ignore not only the widespread signs of slowing - but the fact that the economy is once again running into rather fierce headwinds?

As I pointed out two weeks ago, last year's stimulants have been replaced by this year's drags. There's no tax cut this year, rising long-term rates have all but choked off the re-fi boom, housing is slowing, the dollar is up while the stock market is down, and higher energy costs are sapping buying power. Read Kellner's earlier column.

The fed funds futures market currently expects the Fed to double the funds rate by yearend. It may happen - but then again, it may not.

The markets have wrongly predicted rising rates since the summer of 2001.

This pretty much tallies with my own analysis of the situation. Thanks for the reference Jim!